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Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence

52 Pages Posted: 19 Jun 2004  

Robert S. Gibbons

Massachusetts Institute of Technology - Sloan School and Department of Economics; National Bureau of Economic Research (NBER)

Kevin J. Murphy

University of Southern California - Marshall School of Business; USC Gould School of Law

Date Written: July 1991

Abstract

This paper studies career concerns -- concerns about the effects of current performance on future compensation -- and describes how optimal incentive contracts are affected when career concerns are taken into account. Career concerns arise frequently: they occur whenever the market uses a worker's current output to update its belief about the worker's ability and competition then forces future wages (or wage contracts) to reflect these updated beliefs. Career concerns are stronger when a worker is further from retirement, because a longer prospective career increases the return to changing the market's belief. In the presence of career concerns, the optimal compensation contract optimizes total incentives -- the combination of the implicit incentives from career concerns and the explicit incentives from the compensation contract. Thus, the explicit incentives from the optimal compensation contract should be strongest when a worker is close to retirement. We find empirical support for this prediction in the relation between chief-executive compensation and stock-market performance.

Suggested Citation

Gibbons, Robert S. and Murphy, Kevin J., Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence (July 1991). NBER Working Paper No. w3792. Available at SSRN: https://ssrn.com/abstract=420290

Robert S. Gibbons (Contact Author)

Massachusetts Institute of Technology - Sloan School and Department of Economics ( email )

E52-432
MIT
Cambridge, MA 02142
United States
617-253-0283 (Phone)
617-258-6855 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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Kevin J. Murphy

University of Southern California - Marshall School of Business ( email )

BRI 308, MC 0804
Los Angeles, CA 90089-0804
United States
213-740-6553 (Phone)
213-740-6650 (Fax)

USC Gould School of Law

699 Exposition Boulevard
Los Angeles, CA 90089
United States

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